Tag Archives: PPI

The Payment Protection Insurance (PPI) mis-selling scandal has only just come to a head. Banks are facing compensation claims of as much as £6bn from customers duped into buying insurance they didn’t need.

And now big UK banks will be all over the papers again – this time for mis-selling another sort of insurance, this time to small businesses.

Here’s how it works…

You’re a small business and you take out a loan with a bank. And just like with PPI, the bank wants to hit you with some “insurance”. Making interest on a loan isn’t enough for these guys. They want to optimise !!!

With a small business, banks cannot sell critical illness or redundancy insurance. So they have to be a little more imaginative.

The idea went a little like this: “Hey, that loan you’re taking… Now you’d be a fool not to want to protect your business against interest rate moves. Look, we’ll put together an interest rate swap contract. Basically, if rates move against you, this contract will pay out…”

But what many business owners didn’t realise was that if interest rates moved down (which of course they did) then they’d be on the hook for potentially hundreds and thousands of pounds.

And you can bet the banks were keen on shifting these policies. This from the Sunday Telegraph:

“The case of Adcocks (a small electronics retailer) highlights just how much of an edge the banks had. Following 12 months of what Mr Adcock describes as “encouragement” from his local Barclays relationship manager, the company in February 2007 took out an interest rate hedge on its £970,000 of borrowings from the bank. Unbeknownst to Mr Adcock, on the day he signed the agreement, Barclays Capital, the bank’s investment banking arm that structured the deal, is likely to have booked a profit of as much as £100,000 from the sale of the hedge.”

These interest rates swaps have driven some businesses into administration. The banks have been siphoning cash straight out of business accounts as a result of ‘adverse moves’ in the interest swap.

Professor Michael Dempster of the University of Cambridge’s Centre for Financial Research said: “I liken it to going to bet on a horse race having fixed the result. You’re not guaranteed to win, but you have a heck of an edge on the punters.”

All this could mean more huge claims against the banks. Prof. Dempster said “I think this could be at least the same size as PPI.”

So it’s clearly another savage blow for the UK’s retail banks. If you aren’t already out of the banking sector, then these sorts of shenanigans ought to make you think twice about holding bank shares.

We have all known for some time that the ongoing banking crisis was originally started by some sort of banker-naughtiness and what we have in common with the vast majority of Bank Directors is that we don’t really understand WHAT happened. But we do know that someone somewhere is guilty and needs to be spoken to very severely.

It was good to hear that the US government via its regulator (Federal Housing Finance Agency), has filed suit against seventeen financial institutions. Specifically, they want answers as to why $200 billion in bad mortgage-backed securities was sold to mortgage companies Fannie May and Freddie Mac.

They made their announcement just as the Stock market closed last Friday afternoon – their timing was exactly what you would expect but nevertheless totally wasted. Today will be the day when their proposed action will shake out on the markets. Fortunately for the stock prices, the Swiss have moved to protect their own currency which has had a small positive impact on equities.

So what did the bankers do?

Imagine that a bank grants a $100,000 mortgage which results in the borrower repaying say, $1000 per month. Now imagine 1000 such mortgages. If the mortgages were pooled , you’d have a “product” which generates an income $1,000,000 per month. Then you sell shares in the product to investors such as other financial institutions. Here comes the good bit: You omit to tell the institutions buying shares in your new product that the mortgagors (the borrowers) have absolutely no chance of making the $1000 per month repayments. Thus, the banks sold and also invested in worthless products because they could not generate any income.

These were the famous Sub-prime Bonds. The term “sub-prime” describes the borrowers – the so-called NINJAS to whom the banks lent billions. NINJAS? No Income, No Job or Assets.

(That was a very simplified explanation but it does demonstrate the principle of dealing in debt – you create debt by lending and then sell shares in it).

Embarrassed financial institutions then either sold-on these “investments” and/or attempted to hide their mistakes through the medium of creative accounting, by keeping these items “off balance sheet”.

The US Government’s move on the banks is perfectly justified but any legislation will take years and so leave the banks with permanently damaged balance sheets and income.

The other downside will be that banks, having been bitten once by their OWN greed are unlikely to ever lend money for house purchase as aggressively ever again.

The Fed now fully expects the banks to pay for mortgages which they granted five or six years ago.

Fannie May (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) guaranteed most of the dodgy mortgages and are currently the subject of a Federal takeover and have been placed into conservatorship, which in US law is a form of temporary nationalisation

US banks have so far benefited from a $700 billion Federal bailout but nevertheless both Obama as well as the Federal Reserve have been accused of being too easy on the banks.

In fairness to the American banks, most of the money that they were handed by the Fed has been repaid. However, the rescue of Fannie and Freddie could cost the government as much as $350billion.

To add to the banks’ headaches, they are not only being sued by the US Government but also by many private investors who have also lost money.

So, at a a time when the banking industry is trying to rebuild whilst at the same time being urged to lend, it is having its share values decimated. Then there’s the inevitable and customary Lawyer Bonanza which could add BILLIONS more to their expenses.

The principle of the legal actions is simple: The banks screwed-up through near-fraudulent activities and pushed all Western economies into recession.

Someone HAS to pay.

The FHFA claims that banks were negligent and misrepresented the mortgage-based bonds they were selling because of sloppy underwriting, that is to say, they did NOT carry out proper checks on the people to whom they were lending money.

That is going to be a very difficult defence for the banks.

The FHFA further argues that the Sub-Prime Bonds should NEVER have been marketed because the underlying “assets” did not conform to normal investor criteria. Yet another difficult position to defend.

Meanwhile, some bankers are attempting to shift the blame to Fannie May and Freddie Mac, while others are hoping to settle the claims in order to limit litigation. Our own RBS intends to fight any action. RBS is being sued for over £30 billion.

The most sensible outcome will be for all lawsuits to be settled. That would generate another outflow of cash from the banks but would also draw a firm line under the shenanigans leading up to the 2008 crash.

In the United States, the banks are not just being sued by the government for marketing questionable financial products. They are also being sued in respect of bad foreclosure practices and evictions as well as lawsuits over mortgage debt losses.

Such bank payouts will reduce and weaken their capital levels – further harming banks’ ability to lend.

With politicians everywhere pointlessly (and theatrically) screaming for banks to enable economic growth as well as stimulate housing markets, the road to full economic recovery looks more impossible than ever.

Over here in the UK, we are still awaiting ANY indication from the government of ANY litigation.

So far, the best that we can do is PPI – but even after being TOLD to pay out, our banks continue to drag their feet and not distribute refunds as fast as they might.

It seems that here in the UK, the promise and lure of fat post-Westminster banking directorships is far too strong – as well as the rather ambiguous relationship between our bankers and politicians.

Nowadays, even on the world stage, politicians become bankers and bankers become politicians – especially in Europe.

It’s the ONLY logical reason for our politicians to sanction not-only immunity to our bankers but even after such catastrophic failures, to continue rewarding them with the glittering prize of the over-inflated, stock-market-generated bonus.

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